What to watch when taking equity stakes in urban commercial banks

By Cai Qixiao and Liu Yuzhou, East & Concord Partners
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In recent times, with the intensifying demand for a “full complement of financial licences”, another wave of acquiring equity stakes in commercial banks – especially in urban commercial banks (UCBs) – has rolled in. This is due, on the one hand, to UCBs being smaller in size and easier to control compared to joint stock limited banks, and approval being easier to secure; and on the other hand, to the quality of the assets of UCBs being better than that of rural commercial banks and rural credit co-operatives.

Cai Qixiao Partner East & Concord Partners
Cai Qixiao
Partner
East & Concord Partners

Commercial banks have always been a focus of regulation. The qualifications of bank shareholders, the investing and taking of equity stakes in banks and the qualifications of senior officers are all subject to the examination and approval of the China Banking Regulatory Commission or its agencies.

Accordingly, the role that lawyers play in the course of investment in UCBs is more crucial than investment in ordinary enterprises. Below, the authors outline the methods for investing and taking an equity stake in a UCB, and the things to look out for in doing so.

Investment methods

Subscription for new shares. Due to the macro-economy having entered a downturn and the advancement of market-determined interest rates, the operations of UCBs, particularly in terms of their capital adequacy ratios, are facing greater challenges.

By increasing their capital and shares, and bringing in strategic investors, not only can they enhance their capital adequacy ratios and satisfy regulatory requirements, they can also optimise their share capital structures and obtain more operational resources.

Pursuant to article 40 of the Implementing Measures for the Administrative Permission Matters of Wholly Chinese-owned Commercial Banks, capital and share increase plans require the approval of the banking regulator. When formulating a capital and share increase plan, attention needs to be paid to the offer price for new shares not being less than the net assets per share of the bank, in addition to considering the development strategy.

Acquisition of existing shares. This is also a relatively common choice. The major shareholder of a UCB is usually the local government or a state-owned enterprise controlled by the local government. If the shares to be acquired are state-owned shares, the transferor is required to carry out auditing, appraisal and other procedures in accordance with the requirements of such regulations as the Administrative Measures for the Transfer of State-owned Assets of Financial Enterprises, and list and trade the shares on a qualified property rights exchange.

The lawyers of the transferor are required to issue a legal opinion in accordance with the requirements of the above measures and may assist the transferor in carrying out its internal approval procedure.

The lawyers of the UCB may assist the bank in screening the qualifications of the interested acquirers, in addition to co-operating with the bank in submitting to due diligence by the interested acquirers. In addition to subscriptions for new shares and acquisitions of existing shares, shares of a bank may also be held indirectly through the acquisition of a shareholder of a bank.

Things to look out for

Shareholder qualifications. Pursuant to article 24 of the Commercial Bank Law, if there is a change of at least 5% in the holding of the total capital or total share amount of a shareholder, the same requires the approval of the banking regulator; and article 39 of the measures specifies the approval authority of banking regulators at each level.

Liu Yuzhou Associate East & Concord Partners
Liu Yuzhou
Associate
East & Concord Partners

Such regulations as the Interim Provisions for Investing and Taking an Equity Stake in Financial Institutions, and the Notice on Strengthening the Review of the Qualifications of the Major Shareholders of Small and Medium Commercial Banks also contain provisions on the qualifications of the shareholders of UCBs. The authors recommend that the UCB and the interested investor do a preliminary review and confirmation of the shareholder qualifications of the interested investor before commencing the acquisition procedures.

Expressly specifying whether the new shareholder is eligible for a share of the accumulated profits. In order to avoid a dispute arising during and after the acquisition of the equity stake, it should be specified, in such transaction documents as the capital and share increase plan, and share subscription agreement or share transfer agreement, whether the new shareholder is eligible for a share of the accumulated profits, e.g. retained profits, etc.

In particular, if the equity stake in the UCB is to be taken by way of an acquisition of existing shares, there is a possibility, given the relatively long span of time required for the transaction, that the transaction process could straddle the annual profit distribution of the UCB. If the same is not expressly provided for, a dispute could easily arise over such accumulated profits.

Nomination of directors and supervisors. In recent years, a stream of regulations has been issued including the above measures, the Guidelines for the Work of the Supervisory Boards of Commercial Banks, the Guidelines for the Corporate Governance of Commercial Banks, and the Administrative Measures for the Qualifications of the Directors (Governors) and Senior Management Personnel of Banking Financial Institutions.

Compared to the Company Law, these regulations set forth stricter requirements in respect of the qualifications of directors, supervisors and senior management personnel. Additionally, such regulations as the Guidelines for the Corporate Governance of Commercial Banks limit the number of directors and supervisors that any one shareholder can nominate. When considering whether to take an equity stake in a UCB, the appropriate weight should be given to these provisions.

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Communicating with the local regulators. Authorities such as the banking regulator and finance office of the local government will also formulate detailed regulations on the qualifications of the shareholders, the share capital structure, the mandatory provisions of the articles of association and the qualifications of the directors, supervisors and members of the senior management personnel of the local UCBs in light of actual local circumstances.

The authors recommend that an interested investor communicate with relevant authorities in advance, before acquiring a stake, to understand local policies and requirements, and avoid unnecessary losses.

Cai Qixiao is a partner and Liu Yuzhou is an associate at East & Concord Partners

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E-mail: ahawcai@east-concord.com

liuyuzhou@east-concord.com

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